What is an investment fund?
Investment funds are collective investment schemes which pool your money with that of other investors to give you a stake in a ready-made portfolio. Two of the most popular types are unit trusts and open-ended investment companies (OEICs).
An investment fund can offer a practical and affordable way to invest in lots of different assets without the pressure of making your own calls on individual stocks and shares.
They also enable you to invest in asset classes where buying a diverse portfolio of assets yourself - such as multiple properties - may be impratical.
What are unit trusts and OEICs?
Unit trusts and OEICs are by far the most popular investment funds. With a unit trust, a fund manager buys bonds or shares in companies on the stock market on behalf of the fund.
The fund is split into units, and this is what you’ll buy. The fund manager creates units for new investors and cancels units for those selling out of the fund. The creation of units can be unlimited, hence why the fund is ‘open-ended.’
The price of each unit depends on the net asset value (NAV) of the fund’s underlying investments and is priced once per day. This means that the value of the units you buy directly reflects the underlying value of the investment.
OEICs operate in a similar way to unit trusts except that the fund is actually run as a company. It therefore creates and cancels shares rather than units when investors come in and go out of the fund, but they still directly reflect the value of the assets that your fund manager has invested in.
What is active and passive management?
If you’re placing your money into an investment fund, there are two main strategies you’ll encounter – active management and passive management.
Actively managed funds rely on professional fund managers to select which companies to invest in and when to buy and sell different assets, on your behalf.
Passively managed funds track an investment index: when the fund rises, so does the value of your investment. These are generally referred to as tracker funds.
The aim with active management is to deliver a return that is superior to the market as a whole or, for funds with more conservative investment strategies, to protect capital and lose less value if markets fall. An actively managed fund can offer you the potential for much higher returns than a market provides if your fund manager makes the right calls.
There is no guarantee that they will do so, however, and in many cases passively managed funds will outperform actively managed funds.
Actively managed funds also tend to have significantly higher cost, which will impact on your investment returns (see below).
- Find out more: tracker funds explained
How do unit trusts and OEICs pay returns?
Returns from funds are typically paid through distributions. These can be monthly, quarterly or every six months, depending on the type of fund that you invest in.
These distributions derive from the dividend payments received by the fund from the underlying shares within which they invest, or interest payments from bonds or even rental income in the case of property.
Most unit trusts and OEICs will give you two options to choose from for payment – income or accumulation. Income units pay the distributions as income, while accumulation units wrap up those distributions and reinvest them in the fund, to increase the capital value of your investment.
If you don't need the income, accumulation funds can offer high growth in the long term, because of the compounding of gains.
While it's possible to switch from accumulation to income funds and vice versa, this technically involves buying and selling funds and could trigger capital gains tax, unless your investments are held in an Isa.
Where can unit trusts and OEICs invest?
There are over 2,000 different unit trusts and OEICs available to investors in the UK, investing in over 30 sectors.
These sectors have been categorised by the Investment Association (IA) and are split between the asset class (such as funds investing in equities, fixed interest, and property), geography (such as UK Equity, North America, Japan and Emerging Markets), sector type (such as Technology and Telecoms) and investment style (such as Growth or Income).
Unit trusts and OEICs have evolved a lot over the years and no longer invest simply in one asset, sector or region.
For example, the IA lists three sectors of managed funds - Mixed investment 0-35% shares, Mixed investment 20-60% shares and Mixed investment 40-85% shares - which invest in multiple assets to provide investors with a diversified portfolio housed within one fund.
There are funds that invest in other funds, called multi-manager or fund of funds. Rather than investing directly into individual assets, these funds invest in other collective investments, with the expectation that specialist managers in the various asset classes will produce top performance.
- Find out more: how to build an investment portfolio
How much do unit trusts and OEICs cost?
Most fund groups have now all but given up on initial charges and ongoing charges have typically reduced by half over recent years.
An annual fund management charge of 0.75% the new norm for actively managed funds, rising to around 0.85% when the additional expenses are added to make up the full ongoing charge figure (OCF) which replaces the old TER.
Tracker funds remain much cheaper in most cases, with some index funds now charging less than 0.1% in ongoing charges.
Although small, costs have been found to be the biggest drag on performance in investment funds. The argument for the higher costs is that you’re paying a premium for the expertise and better performance that a professional fund manager can offer.
But the charges are mandatory, even if your manager has returned less than the market or, worse still, lost you money.
Here’s how £1,000 in a fund costing 0.1% and a fund costing 1% would perform in three different investment performance scenarios, ranging from poor (5% loss), to neutral (0% growth) to good (5% growth):
Note: example for illustration only. Assumes consistent loss or growth each year.
Where can you buy unit trusts and OEICs?
Although you can invest directly in some funds, it’s far easier to buy them through an investment platform (often referred to as ‘fund supermarkets’).
We’ve reviewed the major investment platforms; you can find our Which? Recommended Providers here.
Investment platforms also enable you to invest through a stocks and shares Isa, Junior Isa or Lifetime Isa, shielding you from tax and, in the case of the Lifetime Isa, providing extra benefits.
- Find out more: read our reviews of investment platforms